Economy Technology

What are cryptocurrencies and how do they work?

Cryptocurrency: meaning and definition

Cryptocurrency, also called crypto-currency or cryptocurrency, is a digital or virtual currency that uses cryptography to secure transactions. Rather than having a central issuing or regulatory authority, cryptocurrencies use a decentralized system to record transactions and issue new units.

Cryptocurrency – what is it?

Cryptocurrency is a digital payment system that does not rely on banks to verify transactions. A peer-to-peer system allows anyone to send and receive payments anywhere. Unlike physical money that circulates and is exchanged in the real world, cryptocurrency payments exist only in digital currencies in an online database from which specific transactions are made. When transferring cryptocurrency funds, the transactions are recorded in a public ledger. Cryptocurrency is stored in digital wallets.

Cryptocurrency is so-called because it uses cryptography to verify transactions. This means that an advanced encryption system is used to store and transmit cryptocurrency data between wallets and public ledgers. The purpose of encryption is to provide security and safety.

Bitcoin, founded in 2009, was the first cryptocurrency and, to date, is the most popularThe main reason for interest in cryptocurrencies is the desire to do business, and the presence of speculators sometimes causes prices to skyrocket.

How do cryptocurrencies work?

Cryptocurrencies use a distributed public ledger called a blockchain, an up-to-date record of all transactions owned by the holders of the currencies. Cryptocurrency units are created through mining, which leverages computer processing to solve complicated mathematical problems from which coins are generated. Users can also purchase currencies from brokers and then hold and spend them using crypto wallets.

If you own a cryptocurrency, you own nothing tangible. You only have one key that allows you to move a record or unit of measure from one person to another without relying on a third party. Although Bitcoin has been on the market since 2009, cryptocurrencies and blockchain technology applications are still in an emerging stage in financial terms, and more uses are expected in the future. Transactions in bonds, stocks and other financial assets could take place using this technology.

What are Cryptocurrencies?

After seeing how cryptocurrencies work, let’s see which are the best known:

Bitcoins: In 2009, Bitcoin was the first cryptocurrency and is still the most frequently traded. The currency was developed by Satoshi Nakamoto, presumably the pseudonym of a person or group of people whose identity remains unknown.

Ethereum: Developed in 2015, Ethereum is a blockchain platform with its cryptocurrency, Ether (ETH) or Ethereum. It is the most popular cryptocurrency after Bitcoin.

Litecoins: This currency is the closest to Bitcoin but has evolved faster to ensure faster payments and processes and more transactions.

Ripples: Ripple is a distributed ledger system founded in 2012. Ripple can track many different types of transactions, not just in cryptocurrency. The company behind its creation has collaborated with several banks and financial institutions. Non-Bitcoin cryptocurrencies are collectively known as “altcoins” to distinguish them from the originals.

Step 1: Choosing a platform

The first step is to decide which platform to use. In general, you can choose between a traditional broker or a dedicated cryptocurrency exchange platform:

  • Traditional brokers. These online brokers offer various ways to buy and sell cryptocurrencies and other financial assets such as stocks, bonds, and ETFs. While they offer lower trading costs, these platforms also offer fewer features.
  • Cryptocurrency trading platforms. There are many cryptocurrency exchange platforms out there. Each of them offers different options in terms of cryptocurrencies, wallets, interest-bearing accounts and much more. Many exchange platforms have commissions based on assets.

When comparing different platforms, consider what cryptocurrencies are offered, fees charged, security requirements, storage and withdrawal options, and any educational resources.

Step 2: Fund your account

Once you have chosen your platform, the next step is to fund your account so you can start trading. Most cryptocurrency exchange platforms allow users to buy using fiat money (e.g. issued by the government), such as the US dollar, British pound or euro, using credit or debit cards. However, this opportunity varies depending on the platform based.

Credit card cryptocurrency purchases are considered risky and not supported by some exchange platforms. Not even some credit card companies allow cryptocurrency transactions. This is because cryptocurrencies are very volatile, and it is not advisable to risk going into debt (or paying high fees for credit card transactions) for certain assets.

Some platforms will also accept ACH transfers and wire transfers. The payment methods accepted and the time required for deposits or withdrawals vary according to the platform. Similarly, the time required to process deposits varies by payment method.

An essential factor to consider is fees, which include fees for potential deposit and withdrawal transactions and trading fees. Fees will vary by payment method and platform, something to consider at an early stage.

Step 3: Placing an order

You can order through the platform, your broker or an exchange site. If you are thinking of buying cryptocurrencies, select “buy”, choose the type of order, enter the number of cryptocurrencies you wish to purchase and confirm the order. The same procedure applies to “sale” orders.

There are other ways to invest in cryptocurrency as well. Payment services such as PayPal, Cash App and Venmo allow users to buy, sell or hold cryptocurrencies. Here are other investment tools:

  • Bitcoin Trusts: You can buy securities in the form of Bitcoin trusts with a regular brokerage account. These tools allow retail investors to access cryptocurrencies through the stock market. 
  • Bitcoin Mutual Funds: You can choose between Bitcoin ETFs and mutual funds. 
  • Blockchain stocks or ETFs:  You can also indirectly invest in cryptocurrency through blockchain firms specialising in the technology behind cryptocurrencies and related transactions. Alternatively, you can buy stocks or ETFs from blockchain technology companies.

The best option for you will depend on your investment goals and risk appetite.

How to store cryptocurrency

Once you’ve bought your cryptocurrency, you must store it securely to protect it from theft or hacker attacks. Typically, cryptocurrency is held in cryptocurrency wallets, physical devices or online software used to store cryptocurrencies’ private keys securely. Some exchanges offer wallet services, making it easy to hold funds via the platform, but not all exchanges or brokers offer such services.

There are several wallet service providers to choose from. The terms “hot wallet” and “cold wallet” are used:

  • Hot wallets: These refer to cryptocurrency wallets that use online software to protect assets’ private keys.
  • Cold wallets:  Unlike hot wallets, cold wallets (hardware wallets) rely on offline electronic devices to securely store private keys.

Typically, cold wallets charge fees, while hot wallets do not.

How to buy cryptocurrency.

What can you pay with cryptocurrencies?

When Bitcoin was launched, it was meant to be a medium for everyday transactions capable of enabling anything from a coffee to a computer or even real estate. That was not quite the case, and while the number of institutions accepting cryptocurrencies is growing, they are rarely used for large transactions. However, it is possible to pay with cryptocurrencies on various e-commerce sites. Here are some examples:

E-commerce and technology sites: Many companies that sell technology products accept cryptocurrencies on their websites, such as, AT&T and Microsoft. Overstock, an e-commerce platform, was among the first sites to accept Bitcoin. Shopify, Rakuten, and Home Depot also accept them.

Luxury goods: Some luxury goods retailers accept cryptocurrencies as payment. For example, retailer Bitdials offers Rolex, Patek Philippe and other exclusive watches in exchange for Bitcoin.

Automobiles: Some auto retailers, from commercial to high-end dealerships, already accept cryptocurrency as payment.

Insurance: In April 2021, the Swiss insurance company AXA announced that it had started accepting Bitcoins as a payment method for all lines of insurance except life insurance (due to regulatory issues). Premier Shield Insurance, which sells home and auto insurance policies in the United States, also accepts Bitcoin for premium payments. If you want to pay with cryptocurrencies at a retailer that does not accept them directly, you can use a debit card for cryptocurrencies, such as BitPay in the United States.

Cryptocurrency fraud and scams

Unfortunately, crimes related to cryptocurrencies are on the rise. Cryptocurrency scams include:

Fake Websites: Fake websites with fake testimonials and technicalities that promise huge guaranteed returns as long as you keep investing.

Virtual Ponzi Schemes: Cryptocurrency criminals promote non-existent digital currency investment opportunities and create the illusion of huge returns by paying off old investors with new investors’ money. One scam operation alone, BitClub Network, managed to extort more than $700 million before those responsible were charged in December 2019.

Famous personalities as testimonials: online scammers pretend to be billionaires or well-known personalities who promise to multiply investments in a digital currency, while all they do is steal the money received. They can also use messaging apps or chat rooms to spread rumours that a famous businessman supports a specific cryptocurrency. After encouraging investments and monitoring the trend, the scammers sell the shares, and the currency loses value.

Romance Scams: The FBI warns of a trend in online dating scams, where scammers trick people they meet through dating apps or social media into investing or trading in digital currencies. The FBI’s Internet Crime Complaint Center responded to over 1,800 reports of cryptocurrency romance scams in the first seven months of 2021, resulting in losses of $133 million.

In other situations, scammers may pose as legitimate digital currency traders or offer fake exchange platforms to extort money. Another cryptocurrency-related scam involves fraudulent selling strategies of individual cryptocurrency pension plans. Finally, there is the direct hacker attack, whereby criminals hack into digital wallets where digital currencies are stored in order to steal them.

Is cryptocurrency safe?

Cryptocurrencies are usually made using blockchain technology. The term blockchain evokes the recording of transactions in timestamped “blocks”. This is a fairly complex technical process, resulting in a digital ledger of cryptocurrency transactions that hackers are unlikely to tamper with. Additionally, transactions require a two-factor authentication process. For example, you may be required to enter a username and password to initiate a transaction. Then you may need to enter an authentication code received via SMS to your mobile phone.

The fact that security tools are active does not imply that hackers cannot attack cryptocurrencies. Several millionaire attacks have hit cryptocurrency start-ups hard. Hackers caused Coincheck $534 million in damages and BitGrail $195 million in damages, marking two of the biggest cryptocurrency hacks of 2018.

Unlike state-backed cash, the value of digital currencies is determined solely by supply and demand. This can create large swings that translate into significant gains or losses for investors. Cryptocurrency investments are also subject to far less regulatory protection than traditional financial products such as stocks, bonds and mutual funds.

Four tips for safely investing in cryptocurrencies

According to Consumer Reports, all investments carry risk, but some experts consider cryptocurrency one of the riskiest investment choices. These tips can help you make informed decisions if you’re considering investing in cryptocurrencies.

Find out about exchange platforms: Before investing, discover cryptocurrency exchange platforms. It is estimated that there are over 500 trading platforms to choose from. Educate yourself, read reviews and consult with experienced investors before proceeding.

Learn about storing digital currency: If you buy cryptocurrency, you must also hold it. You can keep it on an exchange platform or in a digital wallet. There are different types of wallets, each with advantages, technical requirements and security tools. As in the case of trading platforms, before investing, it is better to inform yourself about the storage options.

Diversify your investments: Diversification is a critical factor for any effective investment strategy, and this is also true when investing in cryptocurrencies. For example, don’t invest all your money in Bitcoin because you don’t know about other cryptocurrencies. There are thousands of options, and it is best to spread your investment across multiple currencies.

Prepare for Volatility: The cryptocurrency market is highly volatile, so be prepared for fluctuations. You will see the prices vary drastically. If you think your investment portfolio or sanity can’t handle it, maybe cryptocurrency isn’t for you. Cryptocurrency is very trendy at the moment but remember, it is still in its infancy and is considered very speculative. Investing in something new poses some challenges, so be prepared. If you think you can get informed and start investing prudently.

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